SELF-EMPLOYMENT CONTRIBUTIONS ACT (SECA)

The Self-Employment Contributions Act (SECA) of 1954 is a tax law that
requires the owners of small businesses—such as S corporations,
partnerships, and sole proprietorships—to pay a tax of 15.3 percent
of their net income from self-employment to cover their own Social
Security, Medicare, and Old Age Survivors and Disability Insurance (OASDI)
costs. Workers who are employed by a company or another person (rather
than being self-employed) only have to pay half this amount, which is
withheld from their paychecks. Their employer pays the other half. In
effect, SECA requires self-employed persons to pay both the employer and
employee portions of the Federal Insurance Contributions Act (FICA) tax (a
combination of Social Security and Medicare). To make this situation more
equitable, small business owners subject to SECA are allowed to deduct
half of their SECA tax amount on their personal federal tax returns.

SECA taxes are computed on the basis of net earnings from self-employment.
Net earnings are defined as the gross income derived from business
activities, less the expenses incurred in the course of doing business. In
this way, ordinary business expenses reduce the SECA tax paid by
individuals. But some other expenses, such as the cost of contributions to
Keogh or Simplified Employee Pension (SEP) retirement plans, are not
deductible for the purposes of
SECA taxes. As a result, SECA makes it more expensive for the owner of a
business to fund his or her own retirement plan than to fund the same plan
for employees, because a larger percentage of employee contributions are
tax deductible. After computing net earnings from self-employment, the
business owner then applies a 15.3 percent rate (based on two separate
rates for Social Security and Medicare) on income up to $60,600. A lower
rate is applied to higher income amounts.

The application of SECA to various types of small business enterprises
came under dispute in the late 1990s. "Self-employment tax is just
another area where the complexity of the tax law yields no easy
solution," Jack Robinson noted in
Outlook
. One issue involved professional activities that were not classified as
trades or businesses, and thus were not subject to self-employment tax. As
Robinson explained, "Carrying on a trade or business requires
regularity of activities, frequency of transactions, and the production of
income." Another issue involved people who were wrongly classified
as independent contractors when the employer's level of control
over their work actually made them employees. Finally, a number of
questions existed regarding the application of self-employment taxes to
members of limited liability corporations (LLCs). Members of
non-professional service LLCs who are considered limited
partners—meaning that they do not have personal liability for the
company's debts, do not have the authority to enter contracts on
behalf of the company, and do not participate in the company's
trade for more than 500 hours during the tax year—are not subject
to self-employment tax.

In general, SECA is believed to adversely affect the small business sector
of the American economy. Many political leaders have indicated that they
feel small businesses hold the key to employment and economic growth. But
legislation increased the SECA rate significantly during the 1980s. Prior
to 1984, the SECA rate was set at 50 percent of the regular FICA rate and
75 percent of the regular OASDI rate, giving self-employed individuals tax
advantages similar to those enjoyed by individuals employed by others. But
between 1984 and 1990, the SECA rate was increased to 100 percent of FICA.
Since FICA rates were already increasing due to double-digit inflation at
that time, SECA rates had to rise even more quickly to catch up. This
increase reduced the after-tax earnings of small firms and thus the
availability of capital for small business expansion. As John Brozovsky
and A. J. Cataldo II wrote in
Management Accounting,
"the small firm is taxed at higher rates on larger amounts,
further hindering its efforts to expand facilities, increase employment,
and provide economic stimulus."